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Reasons Why Investors Should Steer Clear of JAKKS Pacific

Not exempting the current fate of U.S. toymakers, JAKKS Pacific, Inc.JAKK is plagued with declining consumer demand and sales crunch. Further, the company has been witnessing a dismal earnings trend. It reported lower-than-expected bottom line for the six straight quarters.

A look at JAKKS Pacific's price trend reveals that the stock has witnessed an unimpressive run on the bourses in the past year. Shares of the company have lost 25.8% against the industry 's rally of 14.7% in the same time frame. This reflects investors' pessimism on the stock, given the uncertain sales environment.

Let's delve deeper into factors that suggest that you should steer clear of the stock now.

For quite some time, JAKK Pacific is facing a declining demand for its products. Like most other traditional toymakers, the company competes with a broad array of alternative modes of entertainment, including video games, MP3 players, tablets, smartphones and other electronic devices. Due to the shift in demand patterns of kids, the company's revenues are pressurized and are not likely to recover soon. In the second quarter of 2018, net sales declined 11.5% from the year-ago level. Moreover, the Zacks Consensus Estimate for 2018 revenues is pegged at $586.3 million, suggesting a year-over-year decrease of 4.4%.

Rising Costs Affect Profits & Returns

Although JAKKS Pacific's initiatives to boost sales - including the launch of products - and the shift toward more technology-driven toys to revive its brands would aid profits in the long term; costs related to those would hurt the company in the near term.

In the second quarter, gross margin was 26.4%, down 180 basis points (bps) from the prior-year quarter. The metric was negatively impacted by rise in sales reserves and lower selling prices for certain licensed products at the end of the reporting cycle. Subsequently, the consensus estimate for 2018 is pegged at loss of 88 cents per share.

Furthermore, JAKK Pacific's trailing 12-month ROE undercuts its growth potential. Its ROE of a negative 39.1% compares unfavorably with the industry's average of 14.6%, reflecting the fact that it is less efficient in using shareholders' funds.

Toys "R" Us Liquidation Effect to Continue

The U.S. toy industry was taken by surprise when the country's largest independent toy seller, Toys "R" Us filed for bankruptcy in last September. The toy chain also confirmed that it is liquidating its entire U.S. operations (735 Toys "R" Us and Babies "R" Us stores).

JAKKS Pacific, along with other toymakers like Mattel MAT and Hasbro HAS , is affected and is likely to continue to be impacted as a considerable portion of their revenues have been generated from sales to Toys "R" Us. Although retailers like Amazon AMZN have come to rescue these toymakers, those currently don't have shelf spaces as big as Toys "R" Us, which is a concern.

On a year-over-year basis, JAKKS Pacific's net revenues in the first and second quarter of 2018 declined a respective 1.4% and 11.5% due to the liquidation. Toys "R" Us was the last major chain fully dedicated to selling toys. We believe the effect of this liquidation is likely to linger further and the overall industry is expected to grow at a much slower pace for quite some time in the future.

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